The collapse of Lehman Brothers investment bank in 2008 triggered the global financial crisis. Should Greece default on its debt, a second crisis could be precipitated, but the world cannot afford another massive bailout.

The crisis has challenged the foundations of economic globalism.

Globalism is free trade ideology, embracing unrestricted deregulation of the global financial system, of international trade, of labour markets and of many industries, as well as privatisation.

This radical deregulatory system assumed that the world trading system was self-balancing. Surplus exporting nations (like China) would see their currencies rise in value, causing their exports to decline. Net importing nations (like the US and Australia) would see their currencies fall in value, making them more competitive and boost their exports. It was assumed that all major trading nations would abide by free trade principles, in particular the principle of floating exchange rates that allowed currencies to freely fluctuate in value.

However, this is not what happened in the real world. China, following the earlier example of Japan and Germany, artificially manipulated its exchange rate down in value. This mercantilist approach to trade caused huge imbalances in the world trading system. Huge profits from manipulated exchange rates funded the economic growth of Germany, Japan and later China.

Much of the huge trade surpluses of these (and the oil-exporting) countries was channelled into the highly leveraged US and UK financial markets, causing grossly inflated asset values. When the bubble burst in US property (and other) asset markets, it caused the collapse of Lehman Brothers, precipitating the global financial crisis.

It was fortuitous for Beijing that the globalism ideology, begun in the time of UK Prime Minister Margaret Thatcher and US President Ronald Reagan, gave China, with its low-cost manufactures, easy access to the US and Western economies. It permitted China to export its low-priced goods to the West, causing its economy to grow at 10 per cent annually for 30 years.

The causes of the trade imbalances are relatively easy to understand. However, the intricacies of the crisis in global financial markets are more demanding.

Now there are new risks from rising sovereign debt and from the massive increase in government debt resulting from the recent bailouts and stimulus packages.

The Financial Times is the world's leading financial newspaper at the heart of the world's financial markets in London. One of its leading commentators, Martin Wolf, has incisively analysed the nature of the ongoing crisis in a series of recent articles.

Massive trade imbalances

There has been no serious attempt to rebalance world trade. Rather, a fundamental divide continues between the big exporting and the big importing nations, says Wolf.

The big exporting nations want to keep the system going, because they are making so much money exporting their cheap manufactured goods. They refuse to accept that this policy will ultimate rebound on them, once their customers (like the US) "go broke". Indeed, observes Wolf, "that is just what is happening".

Meanwhile, the big importing nations can only cut their huge foreign debts, and de-leverage their private sectors, by a big surge in their exports.

Today's big surplus exporting countries like China will need to expand their domestic market demand to offset their loss of export markets.

Unless this happens, "the world will inevitably be caught in a ‘beggar-my-neighbour' battle: everybody seeks desperately to foist excess supplies on to their trading partners. That was a big part of the catastrophe of the 1930s, too."

Wolf says that, in this economic struggle, today's big exporters, like China, are unlikely to win. If the US is forced to resort to protectionism, it would be bad for China.

He warns, "Those whom the gods wish to destroy, they first make mad." It is not too late, he says, for the major trading nations to work out co-operative solutions.

"Both sides have to seek to adjust. Forget all the self-righteous moralising. Try some plain common sense, instead." (Martin Wolf, Financial Times, March 16, 2010).

Financial doomsday machine

Turning to the financial system, which feeds off the massive financial flows generated by world trade imbalances, Wolf describes how the UK (and by implication, US) financial sector has "become bigger and riskier".

UK banking assets jumped from 50 per cent of GDP to more than 550 per cent over the past 40 years. The UK banks became highly leveraged (i.e., higher debt to capital ratios) and more concentrated in fewer banks.

This is where banks take on riskier investments and lending with lower and lower reserves of capital.

Wolf continues: "Most perilous of all is the compulsion upon the authorities to blow another set of credit bubbles, to forestall the devastating impact of the implosion of the last ones. In the end, what happens to finance is not what matters most but what finance does to the wider economy."

Wolf asks if the huge gains from the highly engineered financial system justify the huge costs from the global financial crisis.

Wolf cites a recent speech by Adair Turner, chairman of the UK's Financial Services Authority, who argues that it does not.

Wolf observes: "Financial systems are important servants of the economy, but poor masters. A large part of the activity of the financial sector seems to be a machine to transfer income and wealth from outsiders to insiders, while increasing the fragility of the economy as a whole."

Even the most ardent "free marketer" would have to admit that there has been a huge transfer of taxpayer wealth to the financial markets from the largest bank bailouts in history, adding new risks to the world economy from a massive rise in government debts.

Wolf says: "It is hard to see any substantial benefit from the massive leveraging up of the economy and, above all, the real estate sector, that we saw recently. This just created illusory gains on the way up and real pain on the way down.…

So what is to be done, asks Wolf. In answering this question, he says that regulation alone cannot halt the "financial doomsday machine". Rather, it will involve fundamental changes to the structure of the financial system. (Martin Wolf, Financial Times, April 20, 2010).

In another recent Financial Times article, Wolf says that several proposals are on the table.

One is for a "narrow banking", where deposit-taking institutions would be regulated, guaranteed and safe, but other riskier financial institutions would be little regulated. "I remain unpersuaded," he says.

Rather, his preferred proposal is one put forward in a new book by Laurence J. Kotlikoff of Boston University, entitled Jimmy Stewart is Dead: Ending the World's Ongoing Financial Plague with Limited Purpose Banking (Wiley & Sons). Kitlikoff argues that financial institutions should not gamble with other people's money, because, if they lose enough, taxpayers are forced to bail them out.

Rather, "instead of having thinly capitalised entities taking risks on the lending side of the balance sheet while promising to redeem fixed obligations, financial institutions would become mutual funds". Depositors in mutual funds are also the owners of the funds.

In this case, he argues: "Risk would then be clearly and explicitly borne by households, who own all the equity, anyway. In this world, financial intermediaries would not pretend to be able to meet obligations that, in many states of the world, they simply cannot."

Wolf says that the Kotlikoff limited-purpose banking proposal doesn't deal with the issue of securing greater macroeconomic stability, or international coordination in an open-world economy. But it makes a key point - fundamental change is needed.

Otherwise, it's likely the major financial institutions will again make the same mistakes together, "thereby creating a panic and threatening the system, with devastating economic consequences.

"This is the Achilles heel of market economies. We have been warned. For battered high-income countries, it will be the flood next time." (Martin Wolf, Financial Times, April 27, 2010).

Sovereign debt threat

The cost of rescuing the world from the global financial crisis has been a massive increase in debt of governments around the world.

Nouriel Roubini, professor of economics at the New York University Stern School of Business, points out that the Organisation for Economic Cooperation and Development "now estimates that public debt-to-GDP ratios in advanced economies will rise to an average of around 100 per cent of GDP".

Roubini goes on to compare the sovereign debt crisis in Greece to that of Argentina between 1998 and 2001. Greece is worse. Its public debt is 120 per cent of the economy, whereas Argentina was only 50 per cent of gross domestic product. Greece's current account deficit is five times worse than that experienced by Argentina.

Argentina ran into a debt trap. Cutting government spending and raising taxes have the effect of reducing demand and contracting the economy (GDP). The net effect can be that government debt-to-GDP worsens, making it harder to pay off debt.

What is needed for Europe's heavily indebted, struggling economies - Portugal, Italy, Ireland, Greece and Spain (the PIIGS) - is the "magic trifecta" of sustainable debt and deficit-to-GDP ratios, a depreciation of their currencies and asset bubbles, and economic growth. This looks unlikely, in part because they all use the Euro currency and cannot depreciate the Euro to expand exports. (Nouriel Roubini, Project Syndicate, April 16, 2010).

Greece will need massive bailouts for at least the next three years.

Failure to solve the Greece and PIIGS crises could lead to yet another financial meltdown on the scale of that caused by the collapse of Lehman Brothers.

John Kay - who has held chairs at Oxford and the London School of Economics and who also writes for the Financial Times - says: "Even if there is will to respond to the next crisis, the capacity to do so many not be there." (John Kay, Financial Times, January 6).

He warns: "When the next crisis hits, and it will, the frustrated public is likely to turn, not just on politicians who have been negligently lavish with public funds, or on the bankers, but on the market system. What is at stake now may not just be the future of finance, but the future of capitalism." (John Kay, Financial Times, UK, October 28, 2009).

Patrick J. Byrne is national vice-president of the National Civic Council.